Economics: Market Failure

Marginal Private Benefits (MPB)

the additional benefits a consumer enjoys from the consumption of an extra unit of a good.

External benefits (externalities)

producing or consuming a good causes an impact on third parties not directly related to the transaction. Externalities can either be positive or negative. They can also occur from production or consumption.

Marginal Social Benefits (MSB)

the extra benefits to society (including the individual consumer) from consuming an extra unit of the good.

MSB = MPB + ext

Marginal Private Costs (MPC)

the additional costs a producer pays for the production of an extra unit of a good.

Marginal Social Cost (MSC)

the extra costs to society (including the individual consumer) from producing an extra unit of the good

MSC = MPC + Ext

Market Failure

Arises when the free market forces, using price mechanism, fail to provide society with the quantities of goods and services it desires

Negative Externalities of Consumption

One Person’s Private Consumption has negative impacts on third parties/ society

Often consumption of demerit goods

Consumers do not take into account harm done to society when consuming a product

MSB < MPB

Q_fm > Q_se → overallocation of resources

OVERCONSUMPTION

Negative Externalities of Consumption Solutions

Indirect Tax

Minimum Price

Pigouvian Tax

Government Regulations

Education

Adveritsement

Demerit Goods

Goods when consumed cause harm to third parties.

Pigouvian Tax

A tax on any market activity that creates a negative externality.

Negative Externalities of Production

The cost imposed on a third party or community by the production at hand

Often consumption of demerit goods

Producers do not take into account harm done to society when consuming a product

MSC < MPC

Qfm > Qse → overallocation of resources

OVERPRODUCTION

Negative Externalities of Production Solutions

Carbon Tax

Tradeable Permits (Cap and Trade)

Carbon Offset

International Agreements

Carbon Tax

sets a price for each unit of carbon emitted, but allows the market to determine the quantity of emissions

Tradeable Permits

A market-based system where the government sets a limit (Cap) on the total amount of emissions allowed. It issues "permits" to pollute, which firms can trade

Carbon Offsetting

Instead of cutting their own emissions, a firm or individual pays for a project that reduces emissions elsewhere to “cancel out” carbon emission

Positive Externalities of Consumption

Benefits which third parties or communities gain from the consumption or production decisions of others.

Often consumption of merit goods

Consumers do not consume enough of the good

MSB > MPB

Qfm < Qse → underallocation of resources

UNDERCONSUMPTION

Merit Goods

The consumption of this good is very beneficial to society

Positive Externalities of Consumption Solutions

Direct Provision

Subsidies

Government advertisment

Legislation (Mandetory consumpition)

Positive Externalitiy of Production

Production that creates benefits to society through the overall process the firm is going through.

Often consumption of merit goods

Producers do not produce enough of the good

MSB > MPB

Qfm < Qse → underallocation of resources

UNDERPRODUCTION

Positive Externalities of Production Solutions

Direct Government Provision

Subsidies

Private Goods

Excludable and Rivalrous

e.g house

Public Goods

Non excludable, non rivalrous

e.g streetlight

Excludable

you can keep someone from consuming the good

for example, you can stop someone from drinking their coffee

Rivalrous

Non shared consumption- one person's use stops others from using it.

Quasi Public Good

They are non rivalrous and non excludable but they could become rivalrous or exludable

e.g highway during traffic or wifi when lots of people are using it

Tragedy of the Commons

Common access resources are susceptible to overuse and are thus prone to ``tragedies of the commons,'' which are present when individual and group interests are in conflict. Individuals act in their own self interest, will ultimately deplete a shared limited resource even when it is clear that it is not in anyone's long-term interest for this to happen.

Common Access Resources

rivalrous, non-excludable

Toll Goods

Excludable, non-rivalrous

Solution to tragedy of the commons

International agreements

Pigouvian Tax

Quotas

Legislation and regulations

Government provision

Education

Tradeable permits

Subsidies

Carbon Tax

Collective Self Governance

Other Forms of Market Failure

Poverty – absolute and relative

Inequality

Discrimination